Plan Confirmation Feasibility: “I Know It When I See It”?

The debtor was a nonprofit that owned a low and moderate income housing cooperative. It proposed a plan of reorganization that contemplated deferring payments to its mortgage lender for six months, using the available cash during that period for renovation of 29 vacant apartments instead. The mortgagee, which was the debtor’s largest creditor, objected.

The mortgagee’s claim was ~$5 million. It was treated as having a secured claim of ~$4.95 million and an unsecured claim for the balance. Since the mortgagee’s secured claim was in a separate class and the mortgagee objected to the plan, the debtor had to address the “cramdown” requirements in order to obtain confirmation of the plan, including demonstrating that the plan was “fair and equitable.”

However, the court noted that the debtor had to meet all of the other applicable confirmation requirements before the cramdown requirements became relevant. In particular, Section 1129(a)(11) of the Bankruptcy Code requires that the plan be feasible, meaning “confirmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan, unless such liquidation or reorganization is proposed in the plan.”

As discussed by the court, this means a “reasonable ‘probability of success, rather than a mere possibility,’” and “requires more than a promise, hope, or unsubstantiated prospect of success.” The goal is to prevent “visionary schemes” that promise more than the debtor can possibly deliver. Rather, “feasibility must be ‘firmly rooted in predictions based on objective fact.’”

The plan proposed payment of the secured claim over three years, with 5.25% interest, and payments of ~$27,000 per month beginning six months after the effective date of the plan. During the first six months, the funds that would otherwise have been paid to the mortgagee would instead be used to renovate 29 vacant apartments in the debtor’s project. The debtor contended that this would allow it to rent out these apartments and achieve a 90% occupancy rate for the project.

The court noted that during the case the debtor provided monthly adequate protection payments of only $19,700 per month, which was significantly less than the planned $27,000 payments. Further, during the case it experienced negative net operating income. The debtor also did not have any cash reserves. So, the court concluded that the debtor did not establish a reasonable probability that it would be able to generate funds sufficient to make the required payments.

Even if the debtor was able to fund renovation of the units, the court did not believe that the units would generate sufficient additional income. The debtor had averaged negative cash flow of ~$6,000 per month. It projected increased monthly rent of ~$11,700 from the 29 units. The cash flow was still short by a couple of thousand dollars. ($19,700 – $6,000 + $11,700 = $25,400).

In addition, while the debtor claimed that the project was very desirable and people were just waiting to lease apartments when they became available, there were only 17 people on a waiting list – which was not sufficient to achieve 90% occupancy, and many of the applications were a couple of years old.

To compound the problem, the debtor’s projection of expenses (1) did not leave sufficient funds to make plan payments, and (2) underestimated expenses since, for example, there was no anticipation of increases in utility expenses arising from the increased occupancy.

The debtor attempted to support its argument that it had a positive cash flow by pointing to its bank statements. However when the court reviewed the statements, it found that the largest balance was due to money turned over to the debtor by a receiver, and the balance had fallen from ~$98,000 to ~$12,000 over six months, and was subject to further reduction based on outstanding checks. At the time of the hearing, the debtor had ~$573 in the bank. Thus, the court concluded that the bank statements reinforced the finding that the debtor’s income was not sufficient to fund the plan.

The court commented that there was no question that the debtor’s principals were dedicated to the project’s success, and the actions taken by the Debtor and others were commendable. But “dedication alone is not sufficient to establish feasibility.” Consequently the court held that the plan was not feasible, so the debtor did not satisfy Section 1129(a)(11), and thus the plan could not be confirmed.

It can be very difficult to convince a court to shut down a debtor’s efforts to reorganize based on a finding that a plan is not feasible. For example, when a debtor proposes a plan that provides for payment in full of the mortgagee (so that the principals can retain equity), with a project appraised at ~$12M based on a cash flow analysis, a secured claim of ~$26M as of confirmation, with the claim expected to increase over the life of the plan to ~$36M due to negative amortization, an objective observer would almost certainly conclude that the plan does not have a snowball’s chance in succeeding. However, a case with similar facts took several months, including testimony by a number of witnesses, for the bankruptcy court to conclude that the plan was not going to be feasible regardless of how many times the debtor tweaked the terms of the plan.